Under Internal Revenue Code Section 408, certain individuals with earned income are eligible to make contributions to various individual retirement accounts and individual retirement annuities. Eligibility rules differ depending upon the type of individual retirement account. For example, generally, anyone under the age of 70½ who earns income from employment may make contributions to a traditional individual retirement account (IRA). For a Roth IRA, contributions may be made as long as the individual has earned income and a modified adjusted gross income below certain thresholds.
Under current law each eligible person may contribute a maximum of $2,000 or 100% of compensation, whichever is less, to either a traditional or Roth IRA annually (or split the maximum between plans, e.g., $ 1,000 to each).
Contributions to traditional IRAs are fully tax-deductible for federal income tax purposes if neither the individual nor their spouse is an active participant in an employer-sponsored qualified retirement plan. The deduction is reduced or eliminated if the individual's modified adjusted gross income exceeds certain thresholds.
Roth IRA contributions are not deductible for federal income tax purposes. However, withdrawals from Roth IRAs that begin after age 59½ are tax-free provided the Roth IRA has been established for more than five years.
Traditional IRA distributions may start after age 59½ and must start no later than age 70½. Withdrawals made prior to age 59½ are generally subject to a 10% penalty tax in addition to income tax. Exceptions to the penalty tax are made for certain distributions. Examples include but are not limited to the following:                Taken in substantially equal amounts over the individual's life expectancy        Occur due to the disability of the owner of the IRA        Are used to pay medical expenses in excess of 7.5% of ADI        
As noted above and clearly stipulated in Internal Revenue Code Section 408, both traditional and Roth IRAs are primarily intended as retirement savings accounts. Furthermore, traditional IRAs only provide favorable federal income tax deductions to those individuals who are not participants in employer-sponsored qualified retirement plans. Deductions are limited or offset completely if current earned income exceeds certain thresholds.
Individuals who are relying upon IRAs as a primary source of retirement income are generally the same people depending upon social security as another prime source of retirement income. Stated differently, people who work for employers sponsoring qualified retirement plan(s) are less dependent upon social security or IRAs for retirement income than people who work for employers offering no retirement plan(s). Even if the current law is liberalized to provide tax savings or incentives to individuals covered by private pension plans, there is a need to assure that targeted savings at retirement are not compromised due to unforeseen circumstances such as disabilities.
Additionally, many employer-sponsored qualified retirement plans provide employee participants certain safeguards with respect to the amount of retirement benefits available at retirement. For example, defined benefit pension plans are qualified retirement plans with employer contributions aggregated annually based upon an actuarially determined plan liability. Current contributions are generally based upon estimates of future employee income levels immediately prior to retirement (e.g., 50% of the final five years' average gross salary) and other actuarial factors such as estimated rates of return on plan assets, liability discount rates, employee turnover, mortality and morbidity. In contrast, benefits under defined contribution plans and hybrid plans such as Cash Balance plans are based upon individual accounts.
Sometimes defined benefit plans provide a disability protection provision. In the event the employee plan participant becomes disabled prior to retirement, the plan continues to accrue benefits as though the employee continued active employment. Hence, the income payable at retirement approximates the retirement income benefit payable had disability not interrupted the active employment of the plan participant.
Defined contribution plans such as 401 (k) plans and non-traditional defined benefit plans such as cash balance plans are becoming increasingly popular. These plans are beginning to offer new forms of protection to disabled employees as well. (Note again the claim of priority and incorporation by reference of U.S. patent application Ser. No. 08/936,037 regarding a method for making such coverage more widely available.)
Private disability coverage, whether sponsored by employers or purchased directly by individuals have overall coverage limitations. Generally, the available coverage is limited to no more than 66⅔% of gross earned income. Insurance companies can be reluctant to provide a higher percentage of coverage due to the risk that a disabled insured will have insufficient economic incentive to go back to work. Often, the percentage of gross earned income covered is considerably lower than 66⅔%. This is because there are generally upper limitations on the amount of compensation covered (expressed in dollars, e.g., $200,000) or because only certain types of income are covered under disability policies (e.g., employer sponsored group long term disability insurance often excludes incentive compensation, commission income and other non-salary compensation from the definition of covered income). Because people who have private disability coverage are likely to receive 66⅔% or less of pre-disability income during disability, they are unlikely to be able to continue contributing to IRAs at pre-disability levels without worsening their present financial hardship.
Of course, millions of Americans have no private disability coverage at all, and social security provides a modest disability benefit, but has an extremely difficult definition of disability qualification to meet. Continuing IRA contributions at pre-disability levels will likely be the least of the financial worries for those who do not own private disability insurance.
Currently, insurance or benefits designed to make up for lost contributions (and the earnings thereon) to traditional IRAs or Roth IRAs resulting from the disability of individual account holders do not exist. There are no known products (insurance or other) on the market that provide this benefit.
Traditional disability income policies pay benefits during the time the person is disabled. Traditional policy designs that pay benefits during the period of disability necessitate disability benefits being paid either; 1) directly to the disabled IRA participant; 2) into the IRA of the disabled participant, or, 3) into some other accumulation vehicle. The purpose of the desired coverage is to prevent diminishment of retirement benefits that would have been accumulated or received had a disability not occurred. It is undesirable for the benefits to be at the immediate disposal or discretion of the disabled participant when the disability occurs. Firstly, the combined coverage may exceed the intended maximum of the insurance company or other benefit provider. For example, as stated previously, most insurers offering individual or group Long Term Disability (LTD) insurance seek to avoid coverage exceeding 66⅔% of compensation. Also, the participant may squander the benefit on current expenses and still suffer diminishment of retirement benefits.
There is a danger that the participant will squander benefits prior to retirement even if the benefit is payable to the IRA instead of to the participant. This is because Internal Revenue Code Section 408 specifically requires that disabled participants be able to access IRA plan assets prior to age 59½ without excise tax in the event of the disability the IRA owner. This provision of IRC Section 408 may explain why annuities sold as qualifying IRA plans have generally not included a “waiver of premium” option. A waiver of premium is an optional feature or rider offered in connection with certain life insurance and or annuity policies whereby premiums are waived under the contract during a qualifying disability. If a traditional waiver of premium approach is used with an IRC Section 408 qualified IRA, benefits (premiums waived plus earnings) must be accessible to the disabled participant immediately. There is therefore no assurance that benefits will not be diminished at retirement. There is also the possibility that the level of combined currently available disability income benefits will exceed the targeted maximum of the issuing insurance companies.
Making the benefit payable to a trust, annuity or other instrument may address this problem. The vehicle must possess the necessary restrictions on withdrawals prior to retirement to assure benefits are ultimately available at retirement. If this approach is used, the applicable taxation of the accumulation vehicle must be taken into consideration. Traditional IRA contributions are sometimes deductible. In addition, the growth (income and gains) of invested contributions is not subject to income taxation until distribution. If the disability benefit is contributed into a vehicle with either nondeductible contributions or currently taxable investment growth, the participant will suffer diminishment of retirement benefits. Because each participant's income tax bracket and situation may differ, this raises an almost infinite number of necessary corrective adjustments to offset the cost of taxes. Deferred annuities are not subject to income taxation on growth until distribution. However, in order for an annuity to completely avoid diminishment, the disability benefit must be grossed up so that the net after tax benefit matches the pre-disability contribution amount (an infinite number of possible corrections). If the disability benefit is paid into a deferred annuity on a tax-free basis, adjustments for non-deductibility may not be necessary. An annuity may also be desirable because some deferred annuities allow contract owners to direct investment options. This may allow the disabled participant to control annuity investment allocations in a fashion similar to IRA plans. However, we believe there are practical economic drawbacks to all of these approaches. Given that the maximum annual IRA contribution for an individual under current law is only $2,000 ($5,000 under proposed legislation), the cost of having dollars flowing into either a trust or annuity with special restrictions, is likely to be prohibitive in relation to the benefit. This may set the stage for a lack of availability of such a plan in connection with IRAs today. Plans using this approach are available in connection with replacing lost contributions to private pension plans (where the annual contribution limits are currently five times higher than for IRAs).
A possible alternative to deferred annuities or other accumulation vehicles that contain restrictions on plan withdrawals prior to retirement, is the disability policy or benefit itself. In order to avoid the diminishment risk described in the proceeding paragraphs, a disability policy or benefit would have to be designed with disability benefit payouts deferred until retirement or other specified time. Additionally, the policy must provide a method of making up for lost asset growth on contributions or hypothetical contributions. This might be accomplished in a number of ways. The policy or benefit could have a stated asset growth rate that the insurance company accrues on contributions and account balances until retirement (at the insurance company's risk). For example, the policy may promise that the annual contribution and account balance will grow at a specified rate (e.g., 8% per annum). If the insurance company earns less than 8% on its reserves, they are still obligated to pay benefits at 8%. If it earns more than the stipulated minimum return, it may either keep the excess return as profit (non-participating policy) or share the excess return with policy-owners in the form of dividends (a participating contract). Instead of a fixed rate of growth, the rate credited to accrued contributions and account balances may be tied to a published index such as a United States Treasury Bond Index or the Standard & Poors 500 Index. Once again, the insurance company may take the risk associated with delivering benefits at the promised growth rate and may issue the policy either on participating or non-participating basis. All of the designs mentioned thus far are examples of general account policies. All policy reserves are held within the general account of the insurance company and are general obligations of the insurance company. Insurance companies might also design a disability policy with policy reserves held in a separate account. The benefit obligations of these policies are supported by the underlying assets held within the separate account and is not a general obligation of the insurance company. Assets held in the separate account are reserved for the exclusive benefit of policyholders and are not chargeable with any other obligation of the insurance company. Annual accrued benefit contributions and account balances within both general account policies and separate account policies may be allocated by participants (generally, among several investment divisions). Under this approach, the investment risk associated with investment performance is borne primarily by each disabled participant (as opposed to the insurer).
Individuals can voluntarily purchase the various disability policy or benefit designs described above or coverage may be made available on some other basis. The financial institution offering a particular IRA product could offer the feature at no charge as a means of competing against other commercial IRA providers. Investment product vendors such as mutual fund companies may incorporate a disability completion feature within certain mutual funds and absorb the cost of providing the feature. They can also offer the feature as an optional benefit and charge higher fees. Insurance companies might provide an annuity with a similar feature or rider and either charge an additional fee or premium or absorb the cost. Employers might pay for a benefit, either insured or otherwise, on the behalf of employees. This is more likely in those situations where an employer makes an IRA available to employees under a payroll deduction plan or on some other sponsored basis.
The form or design of coverage or benefits can vary greatly. Group or individual disability policies may be used. It may be offered through a rider to some other form of insurance policy. The benefit may be provided as an implicit feature or provision of an account or other investment vehicle. The investment vehicle or account in turn might purchase insurance to indemnify all or a portion of the risk. Benefits can be paid in installments or in a lump sum.
Because there are currently no known disability policies or benefits on the market that defer disability benefit payments until retirement (or early retirement), there are no known computer software systems in existence (with the exception of the above-referenced Ser. No. 08/936,037) to track deferred disability payments, benefits, account balances, reserves or obligations. There are no known computer software systems available to track the growth or hypothetical growth of deferred disability benefits at either fixed rates or rates tied to indices with the risk for attaining such growth borne by the insurance companies (either with a participating policy or a non-participating policy), reinsurance companies, mutual fund companies or any other company. There are currently no known systems available to track the growth of deferred disability benefits with the growth of the deferred disability benefits tied to investment options selected by the disabled participant with the investment risk borne by the participant. There are no known computer software systems that calculate reserves, profits, losses, loss ratios, liabilities, or other actuarial factors for disability policies or benefits with benefits deferred until retirement or other specified period. There are no known computer software systems designed for primary insurance companies (insurance companies issuing the deferred disability policy) designed to interact on an automated basis with the computer software systems of reinsurance companies reinsuring deferred disability coverage. There are no known computer software systems available to provide accounting, record keeping or other administrative processes to insurance companies, reinsurance companies, mutual fund companies or any other company desiring to offer disability policies with benefits that are deferred until retirement or early retirement.
In our previous patent application (U.S. patent application Ser. No. 08/936,037), we identified a need for disability coverage protecting retirement benefits of individual participants within certain retirement plans qualified under Internal Revenue Code Section 401(a). We also stated that it may in some instances be preferable to provide such coverage on a deferred basis (deferred until retirement or early retirement). Except for our subsequently discussed invention, we know of no one else who has identified one other potential need to defer the payment of disability benefits until retirement or early retirement in connection with retirement plans qualified under Internal Revenue Code Section 401(a), as follows. Many employers offer two or more retirement plans to employees that are qualified under IRC Section 401(a). In such cases, the employer may wish to provide coverage to protect the contributions made on behalf of individual participants who are participants in more than one plan. In such cases, it may be undesirable to purchase two or more separate policies (one in each of the plans qualified under Internal Revenue Code Section 401(a)) for each participant. This would likely involve unnecessary duplication of certain expenses such as policy administration fees. It would be more economical to purchase a single policy covering all contributions, or an approximation of all contributions made on behalf of a single participant in two or more retirement plans qualified under Internal Revenue Code Section 401(a). This will require placing such coverage in a single retirement plan qualified under Internal Revenue Code Section 401(a). Payment of such consolidated coverage at the time of disability may not always comply with funding limitations for the selected plan. Therefore, it may be necessary to pay such benefits directly to the participant at retirement or early retirement (or the accrued benefit to a beneficiary in the event the participant dies during such period). In making the subsequently discussed invention, we believe that we are the first to have discovered this need or problem.
In recent years, politicians and others have opined that the current U.S. social security retirement system is heading toward fiscal crises. Some believe that the financial danger is attributable to both the changing demographics of the working population (the ratio of people who are employed to the people who are receiving social security retirement benefits has been steadily dropping for decades) and the low investment performance of current social security plan assets.
Historically, social security has not maintained or administered individual retirement accounts. Rather, aggregate plan liabilities determine aggregate funding goals.
In recent years, there have been several federal legislative proposals to reform the U.S. social security retirement system. Among these proposals are plans calling for the establishment of individual social security retirement accounts. Under one recent proposal, workers would be able to select investment options by filling out forms filed with their taxes. Although such plans are not yet in operation for U.S. workers, the present invention is useful for such accounts for workers of those nations that currently provide social security retirement plans with individual plans, and of course the computing for such accounts can be carried out anywhere (such as in the United States).
In light of the future financial problems of the current U.S. social security retirement system, legislation reforming the current system seems almost unavoidable. Currently, social security disability benefits are not based on individual retirement accounts. If legislation is passed that includes the establishment of individual social security retirement accounts, there will be an analogous need for entirely new type(s) of disability benefits protecting retirement benefits. (Note that the present invention is directed to computing operations, such that a particular embodiment of the invention and program code and/or data may reflect changeable but readily discernable matters from whatever facts or law may be applicable, U.S. or otherwise.)
There are many possible ways of preserving individual social security retirement account benefits in the event of disability.
In the case of individual social security retirement accounts, the cost and amount of coverage and benefits may be calculated individually based upon individual contributions or individual account balances. The cost of the benefit may be charged according to individual coverage amounts or may be assessed according to other factors. It may be insured through private insurance companies or self-insured by the Social Security Administration (used herein as an example but intended to encompass the like). If self insured, it may be self-insured through the establishment of a special fund or reserve or the risk can be borne by the system in some other fashion. The Social Security Administration might purchase insurance to indemnify all or a portion of the risk. If insured by private insurance companies, a group policy might be used. Benefits may be deferred until normal retirement or be payable at a special early retirement date. It is possible that both current and deferred benefits may be offered. Current and or deferred benefits might be linked to other social security disability benefits or may be calculated and funded separately.
The existing Social Security Administration computer software system(s) doesn't administer (record, process, measure, facilitate, manage, etc.) disability benefits based upon individual social security retirement accounts because the system doesn't maintain individual retirement account records at all. In fact, currently no known computer software system exists to administer individual social security retirement accounts. A private study (see “Study Finds individual Account Costs Can Be Small” in Defined Contribution News Mar. 29, 1999 Vol. Vii, No. 7) was recently completed by Fred Goldberg, former Internal Revenue Service Commissioner, to assess the cost and feasibility of the creation of a computer system capable of administering approximately 130 million individual social security retirement accounts. While the study was optimistic regarding the cost and feasibility of a computer system to administer such accounts, no such system currently exists. More recently, the Employee Benefit Research Institute (EBRI) published a book titled “Beyond Ideology: Are Individual Social Security Accounts Feasible?” The book is the compilation of the writings and research of 24 distinguished authors. The entire book is dedicated to the questions of whether a system can be developed to administer individual retirement accounts for 148 million workers, and if so, to identify the logistics for implementing and administering such a gargantuan plan. Most of the authors agree that it is feasible, however, there is considerable disagreement as to the feasibility of certain approaches. Although the book is over 200 pages long and provides detailed lists and descriptions of complex tasks a system would have to perform to administer several possible plan designs, there is not a single mention of the need to administer disability benefits as an element of the individual accounts.
These aspects of our subsequently discussed invention are believed to be representative of the background of the invention so far as we know and subject to correction.